International Journal of Islamic Economics and Finance Studies, 2020/2: 119-137

Interest Free Banking in Ethiopia: Prospects and Challenges

Suadiq Mehammed Hailu* Ibrahim Bushera**

Received: 23.01.2020 Accepted: 25.06.2020

DOI: 10.25272/ijisef.678972 Type: Research Article

Abstract
Ethiopia has a substantial number of Muslims estimated more than 38 million. Ethiopia adopted Islamic
banking through interest-free banking window scheme in 2011 and Full-fledged interest-free banking
by the end of 2019. This study aims to investigate the prospects and challenges of the newly adopted
full-fledged interest-free banking system. For these purposes, several secondary data collected and
analyzed descriptively. In addition mainstream media contents are analyzed so as understand public
reaction and perception. The result indicates that Islamic finance has a notable opportunity in Ethiopia.
Unbanked huge customers, lofty demand, the profitability of IFB windows indicate the prospects. While
negative perception toward Islamic finance, legal framework challenges like the exclusiveness of
banking business activity, limitation on investment of banks, tax system and unavailability of
controlling mechanism last but not least lack of experts and skilled resource are identified as the main
impediments of the sector. Therefore, it is recommended to the government of Ethiopia to make
accommodative adjustments on the legal frameworks to resolve the shortcomings and for educational
institutions to provide programs, seminars, and training in the area of Islamic finance in order to
produce experts that serve the sector.

Keywords: Ethiopia, Islamic finance, interest-free window, full-fledged, legal framework

Jel Codes: F65, G2, G21

* Çukurova University, PhD Candidate in Finance, Adana. Turkey. suadiq1434@gmail.com, ORCID:

https://orcid.org/0000-0003-3270-1357
** Ibn Haldun University, Assistant Researcher in Faculty of Business and Economics. Istanbul, Turkey.

ibrahim.bushera@ibnhaldun.edu.tr, ORCID: https://orcid.org/0000-0001-6762-4887

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Suadiq Mehammed Hailu, Ibrahim Bushera

Introduction

It is vivid that, the reason for the emergence of modern Islamic finance is to provide alternative
Sharia-compliant financial services and products for those who are not able to access
conventional financial services due to religious rationale. Gait & Worthington (2007:1) defines
Islamic finance as “financial institutions and products designed to comply with the central
tenets of Sharia (or Islamic law) – is one of the most rapidly growing segments of the global
finance industry”. According to Franzoni and Allali (2018), quite apart from the conventional
finance, Islamic finance is built upon five pillars which are the indispensable measurements of
religious validity (Sharia Compliance) of any financial activity performed under the umbrella
of Islamic finance. These fundamental pillars are prohibition of Riba( interest), ban on
speculative elements in financial contracts(Gharar), Prohibition of gambling (mayser), ban on
the use of trade and investment involving any element of prohibited asset or activity (Haram),
profit and loss sharing principle and the imperative to have real assets underlying any given
financial transaction.

The history of Islamic finance dates back to the era of Prophet Muhammad (Mohamad, et al.,
2013). From the rise of Islam until the 12th century, there were different Sharia-compliant
financial instruments utilized in the Muslim World. Among these financial instruments
accepting deposit, Money transfer, bankers called sarrafeen or sayarifah, Promissory notes
(reqaah al-sayarifah), bills of exchange (suftaja), cheque (sakk) and treasury (Baytal-Mal) were
common (Chachi, 2005; Mohamad, et al., 2013; Alharbi, 2015). The decline of Muslims
civilization, mainly due to gradual deviation from sharia, extravagance, lack of well-
established organization, political breakdown, the rise of different Islamic sects and different
wars shifted the balance of trade from Muslims to Europeans. Consequently, Muslims also lost
their technological and economic advancement. Henceforth, the financial system of all Muslim
countries went astray from Sharia-compliance resulting in the adaptation of the western-based
conventional financial system (Chachi, 2005).

By the mid-19th Century, almost all Muslim countries adopted the interest-based western
financial system (Chachi, 2005). On the subject of adapting conventional financial system
Muslim scholars’ opinion fall into three groups. Scholars in the first group opined accessing
conventional financial services is halal (permitted). Contrary to this, the second group of
scholars argued accessing conventional finance is Haram (prohibited) but, it is also important.
The third group argued that accessing conventional finance is necessary though riba (interest)
is undoubtedly prohibited (haram). The advocator of the third argument suggested that
Islamic sharia has several types of contracts that can be applied in banking business without
interest and it is also possible to establish an interest-free banking system (Nasser 1996, as cited
in Alharabi, 2015).

Finally, in the 1940s, the idea of establishing an interest-free banking system gained
momentum in the theoretical arena, a milestone to modern Islamic finance (Alharabi, 2015).
The first attempt to establish an interest-free bank was commenced in the rural area of Pakistan

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 Interest Free Banking in Ethiopia: Prospects and Challanges

in the 1950s. On 25th July 1963, Mit- Ghamar Islamic saving Bank (MGISB) was established in
Egypt by El-Naggar (Chachi, 2005). In addition to the establishment of Islamic banks, in the
1970s the modern practice of Islamic insurance (Takaful) as well emerged. The first Islamic
insurance company was established in Sudan in 1979. Following the success of this company,
the practice of Takaful expanded through Muslim and Non-Muslim countries (Hussain and
Pasha, 2011). The Islamic model of microfinance project also started in Sudan in the late 1980s
(Mollah and Uddin, 2013).

Islamic finance expanded throughout the Middle East aggressively, and currently, it is
stretching out in all parts of the world. According to the Global Islamic Finance Report (GIFR,
2019), The total capital of Islamic finance has reached US$2.6 trillion at the end of 2018 with a
6.58% annual growth rate. Indonesia, Malaysia, Iran, Saudi Arabia, Sudan, Brunei Darussalam,
UAE, Bangladesh, Kuwait and Pakistan are the top 10 leading countries in Islamic finance
Industry. Based on the total share from the global Islamic finance asset, the leading sectors in
2018 are Islamic banking, Sukuk, Islamic funds and Takaful with 71.7%, 24.2%, 2.8% and 1.3%
shares respectively (IFSB, 2019).

1. The Genesis of Islamic banking in Ethiopia

Ethiopia is a country with a substantial number of Muslim populations. According to the

central statistic Authority of Ethiopia census 2007(CSA, 2007), Muslims account for 34% of the
total population of Ethiopia. Unfortunately, Ethiopia is a country with very law bank service
penetration. The Global Findex Database 2017 states that only 34.8% of adults aged more than
15 years have a bank account. This means 65.2% of adults are not accessing basic financial
services in Ethiopia (Demirgüç-Kunt, et al., 2018). The unavailability of alternative sharia-
compliant financial products and services in Ethiopia played a significant role in inducing
financial exclusion which in turn resulted in law bank usage in Ethiopia (Hailu, Kapusuzoglu,
& Ceylan, 2019).

There was no legal framework that permits the establishment of Islamic finance in Ethiopia
before 2008. As a result, Ethiopian Muslims were demanding for years, the establishment of
Interest free banking service. In 2007, Ethiopian Muslims Diaspora community representatives
presented different questions for the late Prime Minister Meles Zenawi. The request for
permission to establish Islamic banking in Ethiopia was among these questions (Feyissa, 2012).
Furthermore, in 2008, a group of entrepreneurs and community leaders with the aspiration to
establish an Interest free bank named “Zem-zem bank” presented the benefit and importance
of Islamic finance for the late Prime Minister Meles Zenawi. After the meeting, the prime
minister directed the National Bank of Ethiopia (NBE) to issue a new proclamation that
permitted the establishment of Interest-free finance in Ethiopia (Al-Hashimi, 2012).
Consequently, NBE issued a Proclamation concerning Banking Business: Proclamation No:
592/2008. In this Proclamation, Article 22, Sub-article 2 states “The National Bank may issue a
directive to regulate banking businesses related to non-interest-bearing deposit mobilization

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Suadiq Mehammed Hailu, Ibrahim Bushera

and fund utilization.” This was the first practical measures taken by NBE to adopt the practice
of Islamic finance in Ethiopia.

Based on Proclamation No: 592/2008: Article 22, Sub-article 2, all conventional banks in
Ethiopia started to accept interest-free deposits from those customers who are interested in
interest-free banking service. A substantial amount of money is deposited in all conventional
banks, with depositor aiming no more than a safeguard. Currently from the 18 conventional
banks, 10 of them are providing IFB service through window and On the other hand, Zamzam
bank organizers started selling shares in December 2010 to establish a full-fledged Interest free
bank. Though the minimum paid-up capital to establish a bank was 75 million Ethiopian Birr
(2.7 Million USD), Zamzam bank was able to collect 137 million Birr (4.9 million USD), almost
twice as much the minimum paid-up capital, within four months from more than 6800
subscribers (Zam-zam Bank Under formation, 2012). Nevertheless, a new directive was issued
by NBE that undermined the hope of establishing full-fledged Islamic banking in Ethiopia.
This directive is called “Directives to Authorize the Business of interest-Free Banking No. SBB/
51/2011”. According to this directive, only established conventional banks can offer interest-
free banking merely on window modes. Article 2: sub-article 3 defines an interest-free banking
window as a unit within a conventional bank exclusively offering interest-free banking
services”. No explanation was given from the government as to why this directive is decreed
outlawing the former one. Following this directive, Commercial Bank of Ethiopia (CBE) and
Oromia International Bank (OIB) got an endorsement from the NBE to offer interest-free
banking window services in 2013. Currently, almost all conventional banks in Ethiopia are
offering interest-free banking window.

Even though the NBE closed the door to establishing full-fledged Interest free bank in
Ethiopia, Muslim communities did not give up from demanding it. After a 7 years exclusive
interest-free banking window practice in Ethiopia, the NBE issued a new proclamation that
permits the establishment of full-fledged interest-free banking in Ethiopia in May 2019. The
proclamation is known as proclamation No: 1159/2019 to approve for the amendment of
banking business proclamation. In this proclamation article 59 devoted to “interest-free bank”
and sub-article 1 states that:

“Without prejudice to the requirements of specified under the provisions of the proclamation,
the National Bank may issue a Directive to prescribe additional conditions of licensing,
supervision and requirements to establish Interest-Free Bank. For this sub-article, Interest-Free
Bank means a company licensed by National Bank to undertake only interest-free banking
business”.

Proclamation No: 1159/2019 made the dream of establishing a full-fledged interest-free bank
in Ethiopia real. The proclamation was issued after the current Prime Minister Dr, Abiy
Ahmed promised to permit the establishment of full-fledged interest-free banking on his
speech during the Ramadan Iftar (fast-breaking) program organized by the Ethiopian Islamic

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 Interest Free Banking in Ethiopia: Prospects and Challanges

Affairs Supreme Council (EIASC) at Millennium Hall on May 22, 2019 (Getachew & Kedir,
2019).

Following the prime ministers promise and the declaration of proclamation No: 1159/2019,
several share companies queued requesting a license from NBE to provide full-fledged
interest-free banking services in Ethiopia. According to Tadesse (2019), until July 2019, four
banks named Zem-zem, Hijira, Nejashi and Zad were in the stage of establishment, while
another four share companies are in process to get a license from NBE.

Even though the permission of establishing full-fledged interest-free banking in Ethiopia is a

prodigious opportunity for those who were demanding for several years, challenges like the
unavailability of a conducive legal framework, the shortage of skilled professionals, hostile
attitudes towards Islamic bank …etc may affect the performance of interest-free banking in
Ethiopia.

The purpose of this study is investigating the potential opportunities and challenges of full-
fledged interest-free banking in Ethiopia in line of the new enacted directive No. SBB/72/2019.
Accordingly, this study tries to answer for the following two main questions:

• What are the potential opportunities for Islamic Banking in Ethiopia?

• What are the impending challenges for Islamic banking in Ethiopia?

The findings of this study provide significant implications for policy makers who are
responsible in issuing banking business regulation and for investors who are interested to
invest in Islamic Banking sector. Further, this study will contribute to the literature on Islamic
banking in Ethiopia as the newness of the sector and unavailability of adequate literatures.
Finally, it will encourage researchers to do more investigations and academic studies on this
area.

The rest of the paper is set out as follows: In the next section, we analyzed related literatures
on the topic. In Section 4, we describe the methodology applied to explore prospects and
challenges of Islamic banking in Ethiopia. Analyses of the collected data are presented in
Section 5. Summary and conclusions are presented in section 6 and further research directions
are presented in the final section.

2. Literature Review

There are myriads of studies conducted to identify the potential challenges which affect the
performance of Islamic finance. In this section, the common challenges of Islamic finance and
specific challenges at the country level are summarized. Iqbal, Aḥmad & Khan (1998) noted
that the challenges facing Islamic banking are lack of appropriate institutional structure,
competition with conventional banks, lack of innovation of new sharia-compliant financial
instruments, lack of scholars with dual specialization with modern finance and Islamic sharia,
the absence of institutions providing training, teaching and research on Islamic finance and

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Suadiq Mehammed Hailu, Ibrahim Bushera

the unavailability of proper legal framework, policies and procedures to apply Islamic banking
products.

Iqbal & Mirakhor (1999) illustrated the challenges facing Islamic finance by categorizing it into
two groups such as financial engineering and operational challenges. Among the financial
engineering problems that affect the implementation of Islamic finance principles for
additional innovation is the need of special commitment to implement the financial
engineering practices to Islamic banking regarding whether compliant with sharia principles
or not. The absence of legal and institutional frameworks that enhance the application of
Islamic finance principles, the deficiency of an equity-based benchmark or reference rate for
asset pricing or evaluating projects and lack of standards to introduce new sharia-compliant
products are the operational challenges they elaborated.

Karbhari, Naser & Shahin (2004) stated that lack of homogeny, absence of regulation, capital
and liquidity requirements, tax distinction, lack of adequate financial instruments, the
requirement of special accounting practices, the absence of risk management tools, lack of
professionals in Islamic finance and competition with conventional banks are the challenges
faced during the application of Islamic finance in the west. Uppal & Mangla (2014) also
identified global challenges of Islamic banking such as the increasing of competition within
the banking industry; operational challenges including providing products and services at
competitive cost and risk management; and the conflicts of interest between regulatory bodies
and the sharia scholars regarding the application of services and products.

Zamil & Aiza (2014) empirically investigated the problems and challenges facing Islamic
banking in Malaysia. They identified challenges such as the influence of window banking
system, lack of encouragement from the regulatory body related to sharia-compliant products
and services, providing of products and services which are not compliant with sharia
principles, lack of proper operation and management, lack of expertise in human resource,
lack of responsibility, and lack of appropriate accounting and auditing practice. Tabash (2017)
investigated the critical challenges affecting Islamic banking in India using the analytic
hierarchy process. His finding indicated that the absence of proper regulatory framework, lack
of experts in Islamic banking, lack of awareness regarding Islamic banking, absence of
standard-setting and lack of collaboration and harmonization between Islamic banks are the
main challenges facing Islamic banks in India.

Studies conducted to assess the challenges of interest-free window banking practice in

Ethiopia are reviewed as follows. Muhumed (2012), Ali (2016), Tsion (2017), Getachew (2018),
Jemal (2018), Bati (2018) and Wondwosen (2018) identified challenges facing the interest-free
banking window practice in Ethiopia such as lack of conducive legal framework and lack of
cooperation from government, absence of Shariah advisor, lack of skilled human resource, lack
of awareness of clients, unavailability of effective supervision by NBE, negative perception
regarding interest-free finance resulted from unjust association with religious extremism,
absence of equity markets, lack of collaboration between interest-free window providers, lack

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 Interest Free Banking in Ethiopia: Prospects and Challanges

of set-up appropriate for Interest-free banking business, insufficient marketing and

advertising, double taxation and the absence of standardization.

Abate (2016) assessed the Ethiopian interest-free banking regulation in light of global Islamic
finance standards and concluded that using as a legal frame work the existing single and
sketchy proclamation No. SBB/ 51/2011 to govern interest-free banking service will be a
challenge. He recommended NBE to develop a comprehensive directive for a smooth
application of interest-free banking system. Sefiani (2014) states that the absence of a suitable
legal framework, the lack of skilled Islamic banking experts and inadequate awareness about
Islamic finance products are the challenges of Interest-free banking practice in Ethiopia. Sefiani
recommended the NBE to revise the proclamation No. SBB/ 51/2011 in order to resolve legal
problems affecting the interest-free banks such as participation in non-banking business,
value-added tax on merchandises and double taxation. Aman (2019) descriptively analyzed
the expansion and financial performance of IFB windows in Ethiopia. His findings indicate
that IFB windows in Ethiopia were able to exponentially expand their deposit accumulation
through IFB. Moreover, their financial performance expressed in terms of income and
profitability is showing substantial growth.

Ahmed (2019) investigated Ethiopian interest-free banking proclamation after the enactment
of Directive No. SBB/72/2019. According to Ahmed (2019), there is no difference between the
proclamation No. SBB/ 51/2011 and Directive No. SBB/72/2019. Moreover, the legal framework
of Ethiopia is not appropriate for launching full-fledged interest-free banking. Accordingly,
there is a need for a conducive legal framework to practice full-fledged interest-free banking
in Ethiopia.

3. Research Methodology

As mentioned earlier in the introduction section, four fully-fledged Interest free banks are
under formation. Two of them have already raised the minimum paid-up capital required to
start a bank and established board of directors. Hopefully, they will join the finance sector in
a very short time. The aim of this paper is assessing the available opportunities and challenges
which may affect the performances of interest-free banking business in Ethiopia. To
investigate the opportunities for interest-free finance in Ethiopia, this paper will analyze
secondary data gathered from diverse sources. Regarding the effectiveness of interest-free
window banking, we analyzed available annual reports of banks in addition to other
secondary data that can show the potential prospect of interest free banking in Ethiopia.

Although there are various challenges faced by Islamic banks, in this paper we will focus on
three categories of challenges we presume to have a significant impact on the performances of
Interest free banks. Accordingly, the three categories of key challenges are negative perception
toward interest-free banking, legal framework challenges and shortages of experts and skilled
human resources. To investigate perceptions toward interest-free finance, we analyzed the
social and mainstream media reactions following Prime minister Dr, Abiy Ahmed’s vow for
the establishment of full-fledged interest-free banking on May 22, 2019. The potential

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Suadiq Mehammed Hailu, Ibrahim Bushera

challenges regarding legal frameworks are identified by thoroughly examining the banking
business proclamations in light of international practices. Finally, challenges related to the
shortage of experts and skilled human resources are assessed in accordance with the education
system of the country, in addition to the related literature review.

4. Analysis

4.1. Opportunities for Islamic banking in Ethiopia

4.1.1. Huge Amount of Potential Customer

There are several potential opportunities for Interest free finance in Ethiopia. Among these
opportunities, the first one is the availability of huge potential customers who have been
excluded from accessing conventional finance products and services mainly due to religious
reasons. The success of every business is mainly depending on the availability of potential
customers who can access the products and services provided. As the basic principles of
Islamic finance are originated from Sharia rules, it is expected to be Muslims are the primary
customers for Interest free finance products and services. According to the World Population
Review (2019) estimation, the population of Ethiopian reached 113 million and 34% (38.5
million) out of the total population are Muslims. The availability of a substantial Muslim
population is the primary potential opportunity for the expansion of Interest free finance in
Ethiopia. The ever increasing number of banks providing IFB service in window and
subsidiary model, and customers who have accounts in these window services is another
indicator of huge amount of potential customer. In 2018 only Oromia International bank and
Cooperative bank of Oromia had 248,614 and 660,000 customers of IFB respectively (Aman,
2019).

4.1.2. High Popular Demand

The second opportunity that encourages Interest free banking in Ethiopia is the high popular
demand for it from the Muslim population manifested for a protracted period. Ethiopian
Muslims were expressing their demand to interest-free finance through different ways to the
government. The request of Ethiopian Muslim Diaspora representatives and the establishment
journey of Zamzam Bank from 2008 to 2011 are the main events which indicate the resolute
demand of Ethiopian Muslims for Interest-free finance. These events are described in the
introduction section more meticulously. Concerning this point, Hailu et al (2019) surveyed 321
respondents in Addis Ababa, the capital city of Ethiopia by asking the respondents plan if full-
fledged interest-free banking is allowed in Ethiopia. 64.5% of respondents indicated that they
will access the products and services and 33.6% of them expressed their interest to be a
shareholder in full-fledged interest-free bank. The ever increasing number of IFB service users
in the window model is additional evidence that portrays the higher demand for IFB service.
Given the fact that the windows are providing limited IFB products (Aman, 2019) and the
concern regarding sharia compliance of IFB window will be an adequate reason for customers
to use fully-fledged banks.

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 Interest Free Banking in Ethiopia: Prospects and Challanges

4.1.3. Easy Deposit Mobilization and Profitability of IFB Windows

The third opportunity that signifies the potential effectiveness of full-fledged interest-free
banking in Ethiopia is the success of Interest-free banking windows in collecting huge amount
of money through interest-free deposit schemes. According to Tadesse (2019), from a total of
17 state-owned and private banks in Ethiopia, 11 banks accepted the license to provide
interest-free banking window services and 10 of them already launched the services. Deposits
are collected mostly by three types of accounts such as Amanah (current account), Wadi’a
(saving account) and Mudarabah (profit sharing account). The state-owned Commercial bank
of Ethiopia (CBE) that dominated the banking sector in Ethiopia also dominated the interest-
free banking window services. Tadesse (2019) noted that the total deposit collected by all
commercial banks providing interest-free window services at the end of May 2019 was 40
Billion Ethiopian Birr (1.5 billion USD) and CBE has a 66% share from this deposit. Cooperative
Bank of Oromia (CBO), Oromia International Bank (OIB) and Awash Bank (AB) also has a
substantial share from the total deposit collected throughout the country. Taye (2019) states
that, the total amount of deposit collected by all interest-free banking window service provider
commercial banks was 20 billion ETB (715 million USD) before 2 years and it reached now 40
billion ETB (1.5 billion USD) . Thus, deposit mobilization in interest-free window banking in
Ethiopia shows a 100% increase within just 2 years.

Table 1: Deposit collected and Income generated by CBE, CBO and OIB from IFB window

BANK IFBW deposit in ETB* Growth in IFBW profit in ETB Growth

2018 2019 Deposit 2018 2019 in %
CBE** 14 billion 25 billion 78.57% - - -
CBO*** 2.2 billion 5 billion 125.23% 20.36 million 77.58 million 281%
OIB**** 3 billion 4.16 billion 38% 223 million 244 million 9%
Sources:
* USD/ETB rate is 1/28
** 14 billion per February 8,2019 and 25 billion per 13 October 2019
*** Collected from CBO 2018/2019 annual report
**** Collected from OIB 2018/2019 annual report

The interest-free deposit collected and the income generated from interest-free services in 2018
and 2019 by CBE, CBO and OIB are summarized in Table 1. There is a significant growth in
the amount of deposit collected and the income generated from IFB window services. Despite
the economies of scale advantage conventional banks enjoy when providing IFB window
service, the tremendous growth in deposit mobilization and higher profit margin they earned
by providing a restrictive IFB window service indicate the potential for full-fledged interest-
free banks to be profitable by providing a wide range of Sharia Compliant products and
services. Aman (2019) analyzed the performance of IFB windows. His findings indicate an
incredible growth of profitability. Ahmed (2019) investigated the expansion and performance

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Suadiq Mehammed Hailu, Ibrahim Bushera

in deposit mobilization and financing of interest-free banking window. He concludes that the
emergence of full-fledged interest-free finance in Ethiopia has a potential opportunity.

To sum up, the availability of huge potential customers who could not access conventional
finance products and services mainly due to religious reasons, the high demands of Muslims
for full-fledged interest-free banking, the success of Interest-free banking window providers
in collecting a significant amount of interest-free deposit through a restricted services, and
success of under formation full-fledged interest-free banks in collection of paid capital by
selling shares to the public within a short period are the golden opportunities for Interest free
finance in Ethiopia.

4.2. Challenges for Fully Fledged Interest Free Banking in Ethiopia

4.2.1. Negative Perception towards Interest-free Banking

After a protracted struggle and determined demand, Ethiopian Muslims heard the good news
through the promise of PM Dr Abiy in May 2019, at an IFTAR event organized by Ethiopian
Islamic Affairs Council, to allow the establishment of fully-fledged Interest free bank in
Ethiopia. Nevertheless, the news is not welcomed by all. As mentioned earlier in the
methodology section, we employ content analysis to measure the perception towards Islamic
bank. Hence, we assessed the public response under the news that disclosed the PM’s vow to
allow the establishment of an Interest free bank. First, we examined comments given under
news published on a Face book page of Fana Broadcasting Corporate (FBC), a pro-government
mainstream media, regarding the establishment of Interest free bank in Ethiopia.

The post has more than 8 Thousand engagements of which 873 are comments. Most of the
comments are not related to the news. However, a substantial amount of comments related to
the news reflected negative connotations. More than 40 commenter opposed governments
vow to allow the establishment of a full-fledged Interest free bank. The commentaries
mentioned various reasons for their opposition. In general, the opposing comments fall into
four categories. The first group of comments related to the establishment of fully-fledged
banking with religious radicalism. They expressed their concern that the banks will empower
extremists. The second group formed their argument on the notion of secularism. They opined
their opposition stating that, allowing Interest free bank is against the principles of secularism.
The third group of commenter’s claims that allowing the establishment of Islamic banks will
push Christian Ethiopians to demand a Christian bank, which may lead to a division based on
a religious fault line. The last group of comments stated the adequacy of having interest-free
windows under conventional banks. It is clear that these negative perceptions are not peculiar
to Ethiopia (FBC (2019, May 22).

Another implication of the public reaction is a live radio discussion on local Fm named Sheger
FM 102.1 broadcasted on July 11, 2019. In this live radio discussion around 6 attendants called
and participated, of which four callers skeptic about the establishment of fully-fledged Interest
free were banking in Ethiopia. They raised the common biased claim of connecting Islamic

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banking with religious extremism, beside the spurious concern that it will create a religious
fault line in addition to the already existing ethnic division (Sheger FM., 2019, July 11).

The negative perception is not confined to the Non-Muslim community only. Significant
numbers of Muslim Ethiopians have lack of awareness towards Interest free banking and the
service being rendered (Safiani, 2009). A study conducted by Elias Endale (2015) for partial
fulfillment of master’s program titled “Customers` Perception towards Interest-Free Banking
Products and Services: In Selected Branches of Commercial Bank of Ethiopia” also states the
negative perception towards Interest free banking. Both Safiani’s and Endale’s findings
converge with what we have stated above inferring from public reaction express on social and
mainstream media.

Besides the reaction of the public following the announcement of the government to allow the
establishment of fully-fledged Interest free banks, in the following section, we will examine
the perception by analyzing Five mainstream media reports on the issue. The media’s
examined are BBC Amharic, DW Amharic, ESAT TV, Gion Megazine and Addis Maleda.

DW Amharic welcomed Governments decision to allow the establishments of fully-fledged

interest free banks in their article published on July 17, 2019. Besides, they interviewed
organizers of two under formation fully-fledged banks and try to shed light on common
misconceptions regarding Interest free banking. DW Amharic is one of the few media’s which
positively portrayed the relevance of having fully-fledged Interest free bank. BBC Amharic is
another media, which gave a wide coverage for the topic. Though they neither explicitly
welcomed nor opposed the government decision, their report is tantamount to a welcoming
one. BBC Amharic, in their report on July 9, 2019, interviewed a scholar of Islamic finance.
Though most of the questions raised by the journalist have a stereotypic flavor, their effort to
put off misconceptions is plausible.

An interview with Islamic finance scholar name Dr Abdu Seid conducted by ESAT TV on may
27, 2019 is also analyzed for this study. The journalist echoed his concern like IFB is only for
Muslims; IFB is charitable company and the difficulty of controlling IFB. However his concerns
are mere reflections of his wrong perception.

On the other side, reports on Gion magazine and Addis media newspaper opposed the
government’s decision to allow fully-fledged interest free bank. An article published on Gion
Magazine in June 2019 by a famous economic commentator named Kibur Genna, reflects their
discontent and misconceptions they have regarding Islamic finance. Kibur Genna wrote on
Gion magazine that, the government has made a fatal mistake by allowing the establishment
of Interest free bank. He based his argument on spurious cases. He claimed that Interest free
bank will be another divisive factor in Ethiopian politics, though he failed to substantiate his
claim. He further argued that Islamic banks are established to serve merely the Muslim
community, which by no means is acceptable (Genna, 2019, May).

Another print media which is examined for this study is Addis Maleda, a weekly newspaper.
A columnist of Addis Maleda named Yayesew Shimelis wrote an article titled the “politics of

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Islamic banking”. In his article Yayesew audaciously claimed that there are international
extremist groups behind Ethiopia Muslims demand to have a fully-fledged Islamic bank. He
argued that the service provided in window model by conventional banks is more than
enough. For him, Muslim countries are an eternal enemy of Ethiopia. Hence allowing for the
establishment of Islamic bank is allowing Muslim countries, specifically Gulf countries, to
have a huge stake in our economy voraciously. This economic stake will obviously impact our
politics and jeopardize our interest. He additionally argued that allowing Islamic bank will be
both a source and a means of transfer of funds for religious extremists which will bring a
security threat for the country (Shimelis, 2019, June).

4.2.2. Legal Framework Challenges

Different types of approaches have been applied by countries to accommodate the Interest free
banking system in their legal framework. Song & Oosthuizen (2014) identified four types of
adaptation practice in the legal framework such as similar combined regulatory framework
without reference to conventional or Islamic banks, similar combined regulatory framework
by referencing directives applying either to Islamic or conventional banks, distinct legal
framework for Islamic banks and mixed approach with single regulatory framework separate
guidelines for conventional and Islamic banks. The approaches of Ethiopia to accommodate
Interest free banking in its legal framework seems like the second approach, i.e. similar
combined regulatory framework by referencing directives applying either to Islamic or
conventional banks.

Proclamation No:1159/2019, a proclamation to approve the amendment of banking business

proclamation states that “Without prejudice to the requirements of specified under the
provisions of the proclamation, the National Bank may issue a Directive to prescribe additional
conditions of licensing, supervision and requirements to establish Interest-Free Bank”. This
indicates that without prejudice to the regulatory framework enacted to conventional banks,
further guidance for Islamic banks will decree by NBE. One of the basic questions should be
asked at this point is whether Islamic banking principles are applicable under the guidelines
prescribed in the banking business proclamations which ratified by NBE or note. Considering
proclamations related to banking business activities listed under Proclamation No. 592/2008
and amendment Proclamation No:1159/2019, the special activities performed by Islamic banks
are not listed in the proclamation.

One of the basic legal framework challenges for Islamic banks is the directive related to the
limitation on Investment of banks stated in Directive No. SBB/60/2015. Under this directive
article 4 (4) states “A bank may hold up to 10% equity shares in a single non-banking business
other than insurance business” and article 4 (6) also indicated that “A bank’s aggregate equity
investment in all non-bank business, including insurance companies, shall not exceed 10% of
its net worth”. There is no clarity whether these articles are applied for Islamic banks or not. If
it is applicable, Islamic banking products like Mushareka and Mudareba cannot be practiced
in these legal frameworks since most of Islamic banking products depend on equity

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 Interest Free Banking in Ethiopia: Prospects and Challanges

investment. Pertaining to this point, Sefiani (2014) stated that “these articles create a conflict
for issuing Musharaka or a Mudaraba partnership agreement in which a bank could own up
to 100% of a business/transaction at the time of the signing of the contract”.

Another potential challenge for Murabaha (Cost-plus-Profit Sale) transaction which is

rendered by Interest free banks is double taxation. The purpose of Murabaha is providing
goods with mark-up profit instead of giving loan with interest to customers. Accordingly, the
Murabaha transaction is taxed two times when the bank buys the product from suppliers and
when the customer buys from the bank. If direct taxes like income tax from business (trade)
activities and indirect taxes like Value Added Tax (VAT) and Turnover Tax (TOT) are enforced
for Murabaha transaction, this Islamic banking product cannot be competitive and preferable
by customers too.

One of the basic principles of Islamic finance is the services and products provided by Interest
free banks should meet Sharia principles. So, there is a need for responsible authority who
control whether products and services rendered by interest-free banks are compliant with
sharia principles or not. The NBE has nothing to say neither about the controlling mechanism
nor about the responsible body who controls the fulfillment of sharia principles.
Consequently, there is a need to enact a directive by NBE regarding the controlling mechanism
and Sharia board.

In addition to the above-mentioned challenges, NBE does not say anything about the
accounting standards interest-free banks shall adopt. There are three main Islamic financial
standards such as the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI), the Islamic Financial Services Board (IFSB), and the International Islamic Financial
Market (IIFM). Therefore, there is a need to adopt one of these institutions for Islamic banking
practice in Ethiopia, so that consistency and uniformity prevails. In general, the exclusiveness
of banking business activity, limitation on investment of banks, double taxation of Murabaha
transaction, unavailability of controlling mechanism by NBE and not adopting Islamic
financial standards to follow are among the legal framework challenges which affect the
practice of full-fledged interest-free banking in Ethiopia.

4.2.3. Shortages of Islamic Finance Experts

The shortages of Islamic finance experts who have both the conventional finance and Sharia
knowledge is one of the biggest challenges full-fledged Interest free banks encounter. Lack of
Islamic finance experts mainly resulted from the unavailability of educational institution that
provides Islamic finance courses, seminars and trainings. Islamic finance courses are not given
even as a single course in the private and state-owned universities and colleges throughout
the country. Interest-free banking window providers are either sending their staffs for training
in foreign countries or bring experts from other countries. In terms of the cost in either case, it
affects the profitability of the bank. The problem is also observable from the experience of IFB
window providers Sharia advisory board recruitment. Almost all IFB window providers have
organized a sharia advisory board and most of the board members in all banks are traditional

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Suadiq Mehammed Hailu, Ibrahim Bushera

religious teachers not Islamic finance experts. This clearly portrays the fact that, there is a
remarkable shortage of skilled Islamic finance experts that can adversely affect the practice of
IFB in Ethiopia.

Legal frame-work challenges and shortage of experts are not a challenge for Islamic banking
in Ethiopia but also, they are a global challenge for Islamic finance Industry. Bello & Abubakar
(2014) assessed challenges may face for the introduction of Islamic banking in Nigeria. Their
finding indicated that legal frame-work challenges and shortage of experts are among the
main challenges identified. Karbhari et al. (2004) also stated that regulatory problems and lack
of adequately qualified persons in Islamic finance are among main problems that Islamic
banking faces in the UK. Karimi (2007) indicated that the need of special regulatory framework
by Islamic banking is one of the most significant challenges encountering the Islamic banking
industry. Further, Mohd Zamil (2014) and Halim (2011) also identified both regulatory
framework challenges and lack of expertise as a major challenge for Islamic banking industry.
Ahmad & Hassan (2007) and Mzee (2016) stated that absence of a well-defined legal and
controlling framework is one of the main challenges for Islamic banks.

Conclusion

The aim of this study is investigating the potential prospects and challenges of full-fledged
interest-free banks in Ethiopia which are endorsed to the financial industry at the end of 2019.
For this purpose, we analyzed several secondary source data such as reports, magazine,
newspapers, news and previous researches. We analyzed descriptively the data related to the
availability of potential customers, needs, the performance of IFB window providers and the
progress of under formation full-fledged interest-free banks. The result indicated that Islamic
finance has a golden opportunity in Ethiopia such as unbanked huge customers, high-level
needs and the profitability of IFB window. This result converges with conclusion reached by
Ahmed (2019) regarding the potential opportunities of Islamic finance in Ethiopia. In addition
to Ahmed (2019), Aman (2019) also concluded that IFB has a bright future in Ethiopia.

Although Islamic finance in Ethiopia has golden opportunities mentioned above, it is

anticipated that the implementation of this financial system will face many challenges. For this
reason, we analyzed three anticipated challenges such as negative Perception, legal
framework, lack of experts and human resources who are qualified both in conventional and
Islamic finance knowledge. To investigate the perception toward Islamic finance in Ethiopia,
we implemented a content analysis of social and mainstream media reaction and analysis
given following Prime minister Dr. Abiy Ahmed’s vow to facilitate the permission of full-
fledged Islamic banking on May 22, 2019. The finding indicated that there is a negative
perception towards Islamic finance in Ethiopia which is mainly resulted from common
misconceptions. Therefore, there is a need to create awareness about Islamic finance in
Ethiopia trough training, workshop, seminar, social and mass media campaigns.

Legal framework challenges are assessed by analyzing the legal system of Ethiopia in light of
Islamic finance principles. The finding shows that the exclusiveness of banking business

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 Interest Free Banking in Ethiopia: Prospects and Challanges

activity, limitation on investment of banks, tax system and unavailability of controlling

mechanism and not referencing to one of the Islamic financial standards to follow are among
the anticipated legal framework challenges which obviously affect the practice of full-fledged
interest-free banking in Ethiopia. Therefore, it is recommended to the government of Ethiopia
to make adjustments on the legal frameworks in a way that accommodates Islamic finance
practices and enhance their performance in the financial system of the country. The challenge
regarding shortages of experts and skilled human resources is analyzed considering the reality
happening in the sector and this problem is identified as the main challenge for the sector in
Ethiopia. Therefore, there is a need of institutions which can provide undergraduate and
postgraduate programs, seminars, training, researches, etc. in the area of Islamic finance.

Future Research Direction:

It is suggested that there is a need for deep investigation regarding prospects and challenges
of Islamic finance in Ethiopia. The success /failure of interest free window stage in Ethiopia
within 8 years (2011-2019) need a deep investigation. Currently 4 conventional banks in
Ethiopia have started providing Islamic banking services separately through subsidies.
Therefore, there is a need to study the driving force for conventional banks to launch Islamic
banking services by subsidiary in addition to window services. Moreover, economic role of
IFB in Ethiopia can be a potential thematic area for future study.

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Suadiq Mehammed Hailu, Ibrahim Bushera

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